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From Russia with love | 17th November 2014

Why the collapse of the Rouble matters  |  It might well be that President Vladimir Putin needed more sleep, as he said, and therefore left the G20 Summit early in order to rest on the long plane flight home. The Russian economy’s growth in the third quarter of 2014 was just 0.7% and the Delta Economics forecast for trade growth in 2015 is 3.5% – half the level seen in 2014. Some of the drop in trade values may well be due to lower oil prices but this does not explain the fact that imports are forecast to fall from over 9% growth to 4% growth in 2015. If this were not enough, imports of cars have been flat this year and are likely to shrink by 3.5% next. For so long car imports were a proxy for demand for luxury from a burgeoning middle class; so now, even a long plane flight may be too short to recover from the sleepless nights that President Putin may be facing (Figure 1).


Figure 1  |  President Putin’s sleeplessness explained
Source  |  Delta Economics


The collapse in the value of the Rouble cannot be helping Russian policy makers with their insomnia either. The correlation between trade and the value of the Rouble is very low at just 12% suggesting that the currency’s value is unrelated to trade and economic fundamentals but instead has a strong speculative component. When the Rouble was allowed to free-float in November, the result was an immediate devaluation – suddenly connecting it both with the real economy and with the fact that sanctions are making investors nervous.

In contrast, the value of the Moscow MICEX is highly correlated with trade (Figure 2), which helps explain its relative resilience to the battering that the Rouble is currently receiving. Russian export growth, this year at least, remains relatively strong and while this is the case, it can be expected that the MICEX will remain strong too.



Figure 2  |  Monthly value of Russian exports (USDm) vs MICEX,
June 2001-October 2014, Last Price Monthly
Source  |  DeltaMetrics 2014, Bloomberg


Unsurprisingly, Russian exports are 94% correlated with the price of oil (Figure 3). This fact points to two dangers for the world economy.



Figure 3  |  Monthly value of Russian exports (USDm) vs NYSE Arca Oil Spot,
June 2001-October 2014, Last Price Monthly
Source  |  DeltaMetrics 2014, Bloomberg


First, the decline in oil prices itself will cause the value of Russian exports to fall further which at least in part explains our lower trade forecast for 2015. This is bound to have a weakening effect on the Russian economy. Even the effects of strong oil and gas deals with China, which amount to a doubling of trade over the next five years cannot negate lower prices. More than this, China’s growth in mineral fuel imports is forecast to slow from above 11% in 2014 to just above 8% in 2015 and 2016. Russia’s trade growth is increasingly dependent on Chinese imports of fuels – and if these are growing more slowly, then this does not augur well for Russia.

Second, if Russia’s demand for luxury goods is declining then it is bound to have a negative effect on Europe. Figure 4 shows the effects of the fall in Russia’s demand for cars generally on Germany’s exports of cars in particular.



Figure 4  |  Monthly value of German exports of cars to Russia, USDm, vs DAX Index,
June 2001-Oct 2014, Last Price Monthly
Source  |  DeltaMetrics 2014, Bloomberg


So any demand crisis in Russia comes back to affect Europe: the fall in German exports is forecast to continue after a brief respite at the end of Q1 2015 well into Q2 and Q3 of 2015 and, as German car exports to Russia are more than 83% correlated with the value of the DAX Index, this has the potential to create greater instability on European, indeed global, markets The Euro may also experience some fallout as well: German car exports to Russia are 60% correlated with its value.

From a Russian perspective it made sense to form deals with China given the vulnerability both of its own economy and of its relationship with Europe in the wake of the Ukraine crisis. However, there is a perfect storm brewing: a drop in oil prices and a drop in Chinese demand for mineral fuels which could threaten the Russian economy even further than it is currently threatened by sanctions.

There was very little panic on markets around the drop in the value of the Rouble. This is not surprising –the rouble has not been connected with economic fundamentals and it is now so some correction could be expected. But a weaker Russia matters for Europe because of the risks of contagion: the German export engine is being damaged by lower demand for cars and this has a compounded effect both on the value of the Euro and on the value of key European markets, specifically the DAX.